Congress Probes Tax Prep Fraud and Identity Theft

The House Judiciary Committee’s Crime Subcommittee held a hearing Thursday on the growing problem of identity theft and income tax preparation fraud.

“The number of these thefts has increased by approximately 300 percent every year since 2008,” said Judiciary Committee Chairman Lamar Smith, R-Texas. “The Internal Revenue Service detected almost 1 million fake returns among the 2010 returns alone. Tax thieves victimize innocent taxpayers in a number of ways. They often file fake returns under a false name or claim someone who is no longer alive as a dependent on their own forms. Often, the fraud is not detected until an individual files a legitimate tax return that is rejected by the IRS because a false return has already been filed and the refund paid. Tax return identity theft is a very real problem. Congress should do all it can to protect citizens from this crime.”

Smith is one of the original co-sponsors of H.R. 4362, the “Stop Identity Theft Act of 2012,” with Congresswoman Debbie Wasserman Schultz, D-Fla., a bipartisan bill that strengthens criminal penalties for tax return identity thieves. H.R. 4362 adds tax return fraud to the list of predicate offenses for aggravated identity theft and expands the definition of an “identity theft victim” to include businesses and charitable organizations. It also improves coordination between the Justice Department and state and local law enforcement in order to better protect groups that are most vulnerable to tax fraud so they are not future victims.

“The changes to federal law proposed by H.R. 4362 are important to keep pace with this ever-increasing crime,” said Smith. “Tax identity theft costs American families and taxpayers millions of dollars each year. We can help reduce the number of people who are victimized by this crime.”

Sanford Zinman, National Tax Policy Chair of the National Conference of CPA Practitioners, was among the witnesses at the hearing. He noted that the IRS’s Identity Protection Specialized Unit has documented a 280 percent increase in identity theft since 2010. Zinman is a sole practitioner in White Plains, N.Y., who has been preparing individual and small business tax returns, as well as sales tax and payroll tax returns, for over 35 years.

“The real issue is what identity theft does to individuals and what can be done to combat the problem,” said Zinman. “It is reasonable to presume that every American has either been personally affected by identity theft or has known someone who has been a victim. This is a good definition of an epidemic. Identity theft can destroy a person’s life. It can prevent them from buying a house or a car, getting a credit card or even having a bank account. It can even hamper someone’s ability to get a job. The problem of identity theft will not go away.”

He noted that in January the IRS and the Justice Department engaged in a massive national sweep to crack down on suspected identity theft perpetrators as part of a stepped-up effort against refund fraud and identity theft. Working with the Justice Department’s Tax Division and local U.S. Attorneys’ offices, the nationwide effort targeted 105 people in 23 states.

“The Internal Revenue Service has, for many years, recognized the serious issue of identity theft and has instituted measures to combat identity theft and continues to do so,” Zinman added. “However, many of the IRS ‘fixes’ can be cumbersome and time consuming. Beginning in 2008 the IRS implemented Service-wide identity theft indicators which are placed on a taxpayer’s account if the taxpayer claimed they were a victim of identity theft. But these indicators are implemented only after the taxpayer contacts the Service with certain required substantiation documentation. The IRS can then issue an ‘Identity Protection PIN’ which allows the legitimate taxpayer’s return to bypass the identity theft filters. In mid-November 2011 selected taxpayers received an IP PIN Notice letter notifying them that they would be receiving an IP PIN for use when filing their 2011 return. In mid-December 2011 these taxpayers received a second letter with their IP PIN which was a single-use six-digit PIN. Some of these letters caused confusion when returns were filed partly because the program was so new. Some letters were lost, which caused problems with filing returns. Some taxpayers forgot to tell their preparers that they received a letter with an IP PIN. Since this was a limited program the negative impact was very limited. Obviously, better communication could result in better outcomes.”

Taxpayer Advocate Copes with Identity Theft ProblemsNational Taxpayer Advocate Nina Olson noted that she had discussed the problem of taxpayer identity theft in the report she released to Congress on Wednesday (see National Taxpayer Advocate Sees 2013 Filing Season ‘At Risk’). But her experiences with identity theft go back many years.

“My first of many experiences with identity theft occurred when I was the founder and executive director of The Community Tax Law Project, the first independent nonprofit low income taxpayer clinic in the country,” she said. “CTLP provides pro bono legal representation to low-income taxpayers throughout Virginia. In 1993, a legally resident agricultural worker came to CTLP with Internal Revenue Service assessments for additional tax purportedly attributable to unreported wages. My client and I spent the next four years proving to the IRS that it was impossible for him to be working and physically present at three different locations at the same instant. Because the identity thieves—several co-workers on one job from years before—continued to work under my client’s name and Social Security number, we had to prove each year to the IRS that my client did not earn the unreported income. At that time, the IRS did not have any system to flag my client’s account and avoid tormenting and burdening him each year. Somehow, the fact that my client was the victim did not make any impression on the IRS.”

Olson noted that her experiences as a tax lawyer representing clients in identity theft and other cases have served as a guide in her role as the National Taxpayer Advocate at the IRS. She acknowledged that the IRS has adopted many of her office’s recommendations to help victims of identity theft and refund fraud, but believes they need to go further.

“Certainly, refund-driven tax fraud is not a problem the IRS can fully solve, but I believe that the IRS can do much more to detect questionable returns and assist victims of identity theft or return preparer fraud,” she added.

Olson said the IRS should take steps to limit the opportunities for refund fraud, while not unreasonably delaying legitimate refund claims. But she noted that the IRS has been slow to develop procedures to assist victims of return preparer fraud. Olson recommended that the IRS should develop procedures to replace stolen direct deposit refunds, but she cautioned that creating new exceptions to taxpayer privacy protections poses risks and should be approached carefully, if at all.

Mo’ Money Taxes FraudOlson noted one high-profile investigation of a tax return preparation firm has resulted in many TAS cases. On March 14, 2012, the Illinois Attorney General’s office sued Mo’ Money Taxes, a tax preparation service and lender based in Memphis, Tenn. The suit accuses the company of filing unauthorized federal income tax returns and charging undisclosed and exorbitant fees for tax preparation services. The Attorney General alleged the returns were riddled with errors and the company failed to provide some customers with their promised refund checks, Olson noted. The Attorney General’s office contacted her office for assistance, and the Taxpayer Advocate Service agreed to take the following steps: provide information to alleged victims about seeking assistance from the IRS; ensure the IRS was aware that taxpayers would need assistance; and coordinate actions such as holds on collection activity on the taxpayers’ accounts.

To date, TAS has received 76 inquiries related to Mo’ Money issues, all of which resulted in new TAS cases. “We are able to provide some form of relief to the taxpayer in 56.6 percent of the closed cases,” said Olson.

One of the victims of the Mo’ Money identity theft scheme submitted testimony to the committee. “I found out about Mo’ Money Taxes through my family members,” said Michael Robinson. “They were telling me to get Mo’ Money to file my taxes.” He told them that he usually used Jackson Hewitt to file his taxes, but he agreed to visit Mo’ Money to get an estimate of his potential tax refund. They estimated a $3,602 tax refund, but he had a bad feeling and distrusted the firm.

He decided to go to Jackson Hewitt instead, but when his preparer at Jackson Hewitt tried to file his return, she learned that Mo’ Money had already filed the return. The IRS informed her that the agency had already sent a refund check on February 3.

“I was shocked,” said Robinson. He had never received the tax refund, so he and the Jackson Hewitt preparer filed a complaint against Mo’ Money Taxes. An IRS representative discovered when she traced the refund that it had been deposited in Mo’ Money Taxes’ bank account, and not in Robinson’s account.

Guidance on Tax Refund Theft by PreparersOlson said she has issued interim guidance to Taxpayer Advocate Service case advocates on recognizing refund theft by preparers and advocating for the taxpayers. “However, I am disappointed in the IRS’s apparent inability to develop similar procedures to assist victims of return preparer fraud,” said Olson. ”The IRS has failed to unwind the harm done to these taxpayers—even when it had plenty of time to establish procedures. Recently, in response to continued delays by the Wage and Investment division in developing such procedures, I instructed my employees to elevate all cases involving return preparer fraud adjustments to their Local Taxpayer Advocates, who will issue Taxpayer Assistance Orders rather than first submit the request to adjust the case through our normal channels.”

In one egregious instance involving several returns prepared by the same preparer—and despite the IRS’s concurrence that the returns it processed were not the returns signed by the taxpayers—the IRS refused to adjust the taxpayers’ accounts to remove the fabricated income or credits because it did not have procedures in place to do so, Olson noted. In these cases, the Local Taxpayer Advocate issued Taxpayer Assistance Orders to the IRS in December 2010.

“After the IRS refused to comply, I elevated these TAOs to the Commissioner of W&I in July 2011,” she said. “After receiving no response, I further elevated the TAOs in August 2011 to the Deputy Commissioner for Services and Enforcement, who agreed that the IRS needed to correct the victims’ accounts. It was not until the end of March 2012 that the IRS finally made the adjustments—over 18 months after the taxpayers first came to TAS for help.”

“The IRS response to these cases is particularly disturbing because the IRS has been aware of the issue of unscrupulous preparers altering returns in this manner for at least eight years,” Olson added.

In March 2003, she noted, the Refund Crimes section of the IRS’s Criminal Investigation division identified a scheme in which a preparer had altered several hundred of his clients’ returns without their knowledge to increase each refund and then diverted the excess refunds into his own bank account.

“My staff is currently working with the IRS to develop procedures to address return preparer fraud,” said Olson. “But frankly, I find it unacceptable that the IRS needs to be constantly nudged to develop guidance for its employees about a type of return preparer fraud that it has known about for more than eight years, is growing, and is potentially very harmful to the impacted taxpayers. The taxpayers are the victims here, and the IRS should act with all due haste to correct their accounts and eliminate the risk of unlawful collection. Between Taxpayer Assistance Orders, Taxpayer Advocate Directives, the Annual Report to Congress, and now today’s testimony, I am using every tool in my toolbox to try to get the IRS to help these victims of tax fraud. It is astonishing to me that it has taken the IRS this long to act.”

NCCPAP RecommendationsZinman noted that his organization, NCCPAP, has been a strong supporter of identity protection for many years. The group supported the Preparer Tax Identification Number regulations for tax preparers to safeguard the preparer’s Social Security number and has partnered with the IRS in the registration of all tax preparers to reduce the number of unscrupulous preparers who try to take advantage of the IRS modernized e-file system.

NCCPAP has recommended that full Social Security numbers be redacted from documents (such as Form 1099R, 1099 DIV and 1099 INT) which are mailed to taxpayers. The group also recommended that Social Security numbers be removed from client copies of tax returns that are e-filed.

In addition NCCPAP recommends that a dedicated IRS Form 14039 (Identity Theft Affidavit) fax line for victims of identity theft be established. “This would speed up the notification process and would also provide an additional level of security compared with the present system of mailing documentation to the IRS,” said Zinman. NCCPAP also strongly supports H.R. 4362, the STOP Identity Theft Act of 2012 which uses Department of Justice resources with regard to tax return identity theft.

“We agree with the concept that no one agency or department can mitigate the problem alone,” said Zinman. “The problem is too pervasive. We support the concept of the Justice Department working with the Treasury Department. We also support the concept that the federal government reach out to the state governments to attack the problem of identity theft.”